Farm exports are an ever increasing component of farm income. Many farmers export their crops and goods directly, and these farmers should consider forming what is known as an IC-DISC—an Interest-Charge Domestic International Sales Corporation.
Creating an IC-DISC is a very efficient way of permanently reducing your income tax burden, assuming you meet the qualifications. It serves as an export incentive, which is provided through a tax break, for U.S. made products. In the world of farm exports, an IC-DISC is a separate entity that contracts with a farmer to provide services, such as commodity marketing and sales, in exchange for a commission.
A domestic C corporation must request and receive IRS approval to be treated as an IC-DISC. It must maintain a checking account, keep separate accounting records and file U.S. tax returns. However, it doesn’t require an office, employees or tangible assets. Nor is it required to do invoicing.
As an IC-DISC, the company does not pay federal income taxes. The farmer’s tax liability is reduced by converting a portion of net export income, which is taxed at ordinary income tax rates as high as 39.6%, into qualified dividends generally taxed at 0% to 23.8%.
The IC-DISC earns a commission from your farm-related foreign sales. The commission earned is the greater of A) 4% of the farm’s gross receipts from qualified exports, or B) 50% of the farm’s net income from qualified exports. Most calculate their commission using the first option because it’s easier to compute, but the second option might result in a higher commission, leading to greater savings.
The commission your farm pays to the IC-DISC is deductible, whereas the commission earned by the IC-DISC is non-taxable.
This almost sounds too good to be true, but there is one more catch. If you leave the money in the IC-DISC, it is tax free, but most farmers want their money. Therefore, when the funds are paid from the IC-DISC to the farmer, it is treated as a qualified dividend. If you’re in the highest tax bracket, this will be taxed at 20% or 23.8%.
A significant permanent tax benefit results when your farm is taxed at the highest income tax rate of 39.6% and the dividend is only taxed at 23.8%. This ignores state taxes, which usually do not change the bottom line.
If the farmer is a sole proprietor, the tax savings are even greater. In that case, the marginal tax bracket will be about 43% instead of 39.6%. The annual administrative costs should be less than $5,000 for most IC-DISCs, assuming they base commission on overall export sales.
Permanent Savings. For example, Farmer Bean sells non-GMO beans to Japan. His direct foreign sales average $4 million each year, and he is in the highest individual tax bracket. He creates an IC-DISC and during the year pays it a commission of $160,000. He deducts this commission on his tax return, saving $63,360. However, he also pays out a dividend of $160,000 that is taxed at 23.8% or $38,080. He has permanently saved $25,280. If he is self-employed, his permanent savings will be at least $6,000 higher since he can deduct the commission against his self-employment income.
An IC-DISC is not just for those in the highest income tax bracket. In many cases, a self-employed farmer in a lower tax bracket might save even more.
In conclusion, if your direct foreign exports exceed $1 million annually, setting up an IC-DISC might be the way to go.
For more details about IC-DISCs, visit www.TopProducer-Online.com/IC-DISC.
Paul Neiffer is a tax accountant with CliftonLarsonAllen and author of the blog, The Farm CPA. He grew up on a wheat farm in Washington and owns a corn and soybean farm in Missouri. Contact him at paul.neiffer@CLAconnect.com.
- March 2014